U.S.: Subprime Mortgages and the Markets -- an Update

The immediate effects of the U.S. subprime loan situation seem to be leveling out Aug. 14. Global financial conditions likely will improve soon, but longer-term questions about the panic remain.

The short-term global economic effects of the U.S. subprime loan situation appear to be leveling out Aug. 14. Though investors remain nervous, global financial conditions are likely to improve soon. The geopolitical impact of the panic and the larger subprime issue remains minuscule, but there are longer-term questions about how some of the final owners of the U.S. subprime mortgages — the hedge funds — will fare in the coming months and the subsequent effects on the market down the line. Major central banks are returning to their normal operating procedures; some, in an effort to rein in surplus cash, are even recalling the emergency money they put into their national systems. The U.S. Federal Reserve ended its cash injection Aug. 13, while the European Central Bank began normalizing Aug. 14, injecting what is considered to be its final batch of funds. Confirming this global sentiment, the Bank of Japan recalled $13.6 billion out of its system Aug. 14, signaling that Tokyo is confident in its cash on hand. It appears that the worst of the subprime situation is over for now. However, this will not be the last of the U.S. subprime market's global fallout. The fact remains that hedge funds and other large institutional investors — the final holders of the bad debt in the mortgage trading game — are holding on to a lot of bad debt. The high default rate on the subprime loans will cost hedge funds a lot of money, but will not likely lead to a general crisis in hedge funds and institutional investors. They should be able to recover a significant portion of their losses through expected high recovery rates from the sales of foreclosed residential property. However, it will be a rocky road, and some over-extended firms could still go out of business. This will undoubtedly create more global economic ripples until the subprime loan situation reaches its peak, which will be in several years.